Unit 7 Microeconomics: Cost Elements Of Assignment

Unit 7ab224 Microeconomicsunit 7 Assignment Cost Elements Of A Busi

Define and calculate the remaining six major cost elements of a business, when given the total costs and the quantity produced, and determine a minimum cost output level. Explain how the average total cost of a new output level is affected by fixed and variable costs. Explain how the spreading effect and diminishing returns affect the average total cost when producing additional units, including specific examples of production of the 10th and 11th units.

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Understanding the various cost elements is fundamental to analyzing business production and profitability. In microeconomics, these components include fixed costs, variable costs, average variable costs, average total costs, average fixed costs, and marginal costs. Accurately calculating these elements enables firms to make informed decisions about optimal output levels and cost management strategies.

Fixed costs (FC) are expenses that do not change with the level of production within a relevant range. They include costs such as rent and salaries of permanent staff. Variable costs (VC), on the other hand, fluctuate directly with the quantity produced; these include costs like raw materials and direct labor. To compute fixed costs when total costs (TC) and variable costs are known, you subtract total variable costs from total costs: FC = TC - VC. Variable costs themselves are often determined by multiplying the variable cost per unit by the quantity produced, so if VC per unit is known, then VC = variable cost per unit × quantity.

Average variable costs (AVC) are derived by dividing total variable costs by the quantity produced: AVC = VC / Q. This measure indicates the variable expense per unit of output. Average total costs (ATC) include both fixed and variable costs on a per-unit basis and are calculated as ATC = TC / Q. Similarly, average fixed costs (AFC) are obtained by dividing fixed costs by the quantity: AFC = FC / Q. Marginal costs (MC) represent the additional cost incurred from producing one more unit of output. It is calculated as the change in total cost divided by the change in quantity: MC = ΔTC / ΔQ.

Applying these formulas to a manufacturing firm producing smartphones, suppose at 15 units, total cost (TC) is $3,500, and fixed costs are $3,200. To find the variable costs, subtract fixed costs from total costs: VC = TC - FC = $3,500 - $3,200 = $300. The variable cost per unit is then $300 / 15 = $20. To compute the average variable cost: AVC = VC / Q = $300 / 15 = $20. The average total cost is ATC = TC / Q = $3,500 / 15 ≈ $233.33. The average fixed cost at this level is AFC = FC / Q = $3,200 / 15 ≈ $213.33. To determine marginal costs, examine the change in total cost between production levels; for example, if producing the 16th unit increases total cost to $3,520, then MC = ($3,520 - $3,500) / (16 - 15) = $20.

Identifying the minimum cost output level involves analyzing the cost structure to find the output level where the average total cost is minimized. Marginal cost intersects average total cost at this point; when MC ATC, ATC is increasing. The lowest point of the ATC curve indicates the most efficient scale of production for the firm.

The concepts of spreading effect and diminishing returns play crucial roles when producing additional units. The spreading effect refers to how fixed costs are spread over an increasing number of units, reducing average fixed costs as output expands. Conversely, diminishing returns occur when each additional unit of input contributes less to output than previous units, causing marginal costs to rise after a certain level of production. Analyzing two scenarios illustrates these effects:

a. When producing the 10th Gizmo, the ATC is $20, but producing the 11th Gizmo raises the ATC to $22. This indicates that the additional unit's marginal cost exceeds the previous average, likely due to diminishing returns setting in, where output per input unit decreases, increasing the cost per unit.

b. Conversely, when producing the 10th Gizmo has an ATC of $20, but producing the 11th reduces ATC to $18, illustrating the spreading effect. As output increases, the fixed costs are distributed over more units, decreasing the average total cost despite potential diminishing returns in variable input utilization.

References

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